by John Jagerson | July 28, 2010 1:22 am
Forex trading and currency investing doesn’t have to be a game of trial and error. Unfortunately, many traders fall into very common (and very avoidable) traps because they just haven’t taken the time to learn some basic principles.
Or worse, they’re swayed by marketing messages that promise riches from trading without breaking a sweat.
And it’s not just new traders that are hurt. Experienced traders testing new systems or trying new trading strategies commonly get snared by these traps.
By understanding the common mistakes that forex traders make, you can avoid getting caught in the traps that hurt your bottom line.
Back-testing is the process of applying a trading strategy or idea to past price data to see what its performance would have been like.
Theoretically, back-testing should provide some basic expectations about the risks and potential rewards of trading a system in the future.
And even after back-testing, successful traders also practice trading a new strategy or system before trying it in the live market.
Too many traders become discouraged because they do not include enough diversity in their trading strategy. That means that a trader should be diversified across several currency pairs, and a portfolio should have more than one strategy or system active all the time.
Diversifying strategies and investments helps smooth your equity curve and can help you take advantage of changing market conditions, not to mention minimize risk.
We also encourage traders to trade in multiple markets. Forex traders tend to be married to that market alone, but to be truly diversified to control risk and maximize profit, all traders should invest in multiple markets.[1]
Technical analysis can simplify analysis by eliminating subjectivity and is easy to build rules around.
But, it can overlook issues like roll-over, spread and fundamental risk factors. These issues should be accounted for when trading or building a system using only technical analysis, as they can add trading costs and ignore large potential market swings, especially if managed as short-term trades.
Learn more about proper use of Technical
Analysis in Forex Trading.
Very often we see systems establishing a fixed stop and profit-taking limit at the same time an entry limit or market order is placed.
The fixed stop and limit order “bracket” the position. Risk control is critical, but fixed stops may not work in every situation. In some cases, fixed stops will underperform other risk control measures, and each alternative should be evaluated in the back-testing and implementation process.
Logically, most traders would agree that if you can build strategies and systems that work on the hourly charts, you should be able to build systems that work on the daily charts, and vice-versa.
The disadvantage of short-term systems, however, is trading costs. Trades are much more sensitive to slippage in the short term, and the more frequently you trade, the more spreads you absorb into your portfolio. This can quickly eat your trade profits, where a longer-term system requires less transaction
cost.
The big bad world of forex trading becomes a lot less foreboding when you know the right way to play the game.
For more forex education, analysis and reports, visit LearningMarkets.com[2].
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